To track the intended -- and more importantly, unintended -- consequences of policies,market movements,buyout deals and regulatory censure. This forum will map the multiplier effect of what may seem minor events initially but spread out far and wide.

10/13/2010

So you think you are absolutely rational, huh?

Last week, I and my NYU classmates were sent off to track ‘Predictably Irrational*’ behaviour in people and capture this through our own little experiment. It was a tricky one because nearly everyone I knew vouches to be a rational consumer and economic theory backs them all they way in this presumption. There was no way they were going to react irrationally unless I conned them. Just a little bit, in a harmless sort of a way.

Alan Greenspan’s December 1996 expression ‘irrational exuberance’ has been quoted and storied to death in media. I thought may be I could turn the concept inside out, if I could clip people’s usual levels of exuberance!? What if the mind frame in which the decisions were made could be changed– described as relativity’ in Dan Ariely’s book, Predictably Irrational *.

The construct was simple: Ask people that if they won $50,000 in a lottery right away, how would they divide it? They could buy a new car, make a down payment for a new house, shop, invest in the stock market, gold, deposit in a bank or give away in charity.

The control group of 15 people answered the question on a clean slate of mind; the second group of equal size first read dismal data on the US economy and then answered the same question. I made small talk on the data with the second group to ensure a) they had actually read it and b) their risk perception was sufficiently heightened.

I wanted to know if risk-priming, even for 30 seconds, makes people allocate their wealth differently? How generous can people really be if they are bombed with data that makes them edgy about their future? As a journalist, I was simply curious to figure out if screaming headlines can affect decisions?

The results were unambiguous. Ask any researcher and they will tell you it is a eurekaaaaaaaah moment when your data gives you clean results!!

Average allocation for a new house and gold jumped nearly three fold and five-fold after risk-priming while money going into stock market whittled down to a fourth. And generosity went out of the window! Charity fell to one-eighth of the control group levels after people perceived a bleaker outlook for their future. It seems people donate based on their general sense of well being. If they feel they could end up in a corner, they are going to be more self-serving.

Bank deposit figures were surprisingly immune to risk perception but most people said they didn’t have too many alternatives to keep money safe, even if it meant near-zero interest rates. One of my respondents actually wanted to stuff money in her pillow but later decided to stash it away in a bank anyhow.

So yes, we are only as rational as our latest set of thoughts. Tweak it, give it a new context and we jump to a new set of decisions. I pondered earlier but now I know – armed with an excel sheet – that all rationality is relative!

………………………………..

For those who are curious on what data I carpet-bombed my ‘risk-primed’ group with, here goes, hold on tight:

95,000 people lost jobs in September, 2010. Private sector hired but state and federal governments shed 159,000 to increase overall unemployment.

US economy’s unemployment rate is one of its all time high levels of 9.6%.

US will grow at 2.6% in 2010 but slip to 1.9% in 2011. Between 2010 and 2014, it will grow at an average of merely 2.3%.

The interest rate on bank deposits in US is hovering between 0.05% and 0.5%.

In the first nine months this year, 125 banks have failed in US and 829 more have been identified as “problem” institutions by FDIC -- the highest figure since March, 1993.

Economist Nouriel Roubini believes the risk of a “double-dip” recession is increasingly likely. He attaches a 40% probability to it.

US businesses are shuttering nearly 20% more manufacturing plants than they open. This means that there are roughly as many factories now as they were in 1972.

Comments

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It was interesting to read your quick "survey" and conclude the effect of input (the dismal data) that provided the context for their decisions. All decisions are contextual and given the bleak forecast the outcome is not surprising. It further tell that those who were not provided input were not so informed to the current state and the future anticipated. It would also be interesting to determine, what percent of individuals were entrepreneurial and changed their decision that increased risk but also increased the chance of high return in selected sectors of investment, e.g., stocks.

Thanks so much for your comment...yes, it would have been interesting to see how many individuals spotted opportunities in this scenario. May be I can repeat this experiment with a bigger and more diverse sample by getting pple in from diverse backgrounds and occupations. Who knows I might run into the next Warren Buffet, in my survey, who decides to be "greedy when others are fearful and fearful when others are greedy"!

Yes it will be interesting to see the results with a diverse group of peoples. It will also be interesting to turn the sides of the two groups. Those not exposed to eco data to be told about it and their reaction- change or no change in allocation plotted. On the other hand if the group who was exposed to this data may now be assured of "All is Well" and observed if their response change or not.

i am sure the respondent who desired 'safety and warmth' of a pillow to comfort herself and the hard earnings, undoubtedly, got attracted to 'bank failures' in US, which have rather not gone away, in spite of, whole sale (compelled) nationalsation of all banking (especially granting 'undeserved' cushion to the 'notorious and misleading, so-called 'Goldman Sach'(ian) wisdom, drift and thereafter federal assistance provided, so smartly by Paulson(s).

i wish and pray that good sense and discipline is ushered in, as the President has been effective more in rhetoric (to the electorate), confusing to the media, and hardly effective (or making even an iota of permanent change of attitude, heart or strategy with the 'players' of Wall Street; it is evident, are at it 9the same tricks), once again. Power to Berenanke!

Many congrats for coming up with your wonderful survey and amazing results. The impressive tilt towards Bank FDs among the control group shows strong beliefs of people in our banks. It would be interesting to analyse the data across the two sexes.